Kentucky’s recent lottery for medical cannabis cultivation and processing licenses (and upcoming lotteries for dispensaries) has opened the door to a new era for cannabis in the Commonwealth. With licenses now held by the lucky recipients, the marketplace will see an influx of new businesses, and with that, the arrival of mergers and acquisitions (“M&A”). While M&A activity in the cannabis industry has been limited in recent years as a result of capital constraints, regulatory hurdles, operational considerations, and other issues, Kentucky is ripe for M&A in the near term given that it is a new market utilizing a blind lottery to issue a limited number of initial licenses. Kentucky has also set itself apart as a more flexible and fluid market, with the ability of licenses themselves to be transferred separately from the businesses that currently hold them.
For lottery winners who either lack the capital or experience to fully develop their businesses independently, M&A can provide much-needed capital and industry expertise through partnerships with experienced operators. M&A also provides an opportunity for such winners to capitalize on the value of the licenses themselves and transfer them to operators who are better positioned to establish businesses in the Commonwealth. On the other hand, for established industry players in other states, M&A provides an opportunity to enter the Kentucky market.
Unique to Kentucky, and unlike other states where licenses are more tightly held or not as easily transferable, license holders in the Commonwealth may buy and sell the licenses themselves after the Office of Medical Cannabis reviews information regarding the proposed sale and a transition plan and approves the proposed new owners. This means that licenses can be transferred without the associated equity, assets, and liabilities of sellers. For acquirers, this creates an attractive and efficient entry point to quickly scale their footprints.
Of course, M&A also requires careful planning and legal oversight, particularly in the highly regulated cannabis industry. Unlike other sectors, where buyers and sellers can freely negotiate terms, the cannabis industry is bound by layers of federal, state, and even local regulations. This means that each transaction must be carefully structured to stay within regulatory boundaries, and the diligence and regulatory approval phases for cannabis M&A deals are particularly stringent. Both buyers and sellers must ensure that any transaction complies with Kentucky’s medical cannabis laws, particularly when it comes to transfers of ownership and/or control and reported timelines for becoming operational. Failure to properly manage these issues, including not following required notice or pre-approval requirements that vary depending on the scope of the changes, could put the cannabis license at risk.
Sellers in M&A transactions should also be aware of another quirk of the cannabis industry. Cannabis remains illegal at the federal level, which complicates access to traditional financial tools such as loans and institutional investments. While cash is available and certainly used in M&A, consideration for such deals often includes the equity of the acquiring entity. This requires an additional layer of reverse due diligence of the acquirer, and sellers should carefully assess how equity consideration will affect their future exit options and valuations.
The months ahead will be crucial as Kentucky’s new license holders decide whether to build and operate or take advantage of M&A deals that might be too good to ignore. Whether you are a license holder, investor, or multi-state operator or otherwise have interest in the industry, the experienced team of cannabis attorneys at Dentons is here to help you navigate Kentucky’s emerging market.
